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A Silver Lining in the Silvercorp Saga?

Short seller who brought allegations of fraud against miner is alleged to have committed fraud himself.

There was a time when it seemed a day wouldn't pass without some small cap Chinese stock getting outed for fraud. Short-sellers, including Citron Research, Muddy Waters, and Alfred Little, developed a little cottage industry in taking them down -- typically resulting in a hefty profit for themselves. Although many of the targets ended up withering away and disappearing, some still limp along today, like China Green Agriculture and L&L Energy, shells of their former selves.

Not every accusation of skullduggery proved true, of course, but Silvercop Metals(NYSE:SVM) may be one of the very few to survive long enough to see the tables turned on its accuser.

Ying mine. Source: Silvercorp Metals

In August 2011, hedge fund manager Jon Richard Carnes, operating under the pseudonym Alfred Little, outlined for Canadian regulatory authorities what was described as Silvercorp's $1.3 billion questionable accounting scheme, overstating its financial statements and resource deposits. The miner's stock dropped as much as 20% when the allegations became public, and have continued declining since, today trading at around $2.25 per share. So it's likely with bittersweet emotion that Silvercorp learns Canadian securities regulators declared it was Carnes who committed the fraud.

Last Thursday the British Columbia Securities Commission announced it was pursuing a case against the short seller for false statements and misrepresentations in an effort to profit at Silvercorp's expense. It's a rare day that regulators go after such operations, and though short sellers are often vilified by investors for damaging a company's stock and reputation, many times they're performing a service buy-side analysts can't or won't perform on their own. By providing a contrarian look at the bullish commentary emanating from management and brokerages, they give investors an opportunity to revisit their investment thesis.

Sometimes, though, these short attacks are based on faulty assumptions. Tile Shop Holdings(NASDAQ:TTS), for example, was recently exposed for improper ties to a third party, but it also looks like the short seller engaged in some fuzzy math, using improper methods of calculating metrics to come up with more damaging accusations. Its shares remain some 40% below recent highs, however, as the market digests what it means.

Other times it's differences in the reporting requirements of U.S. and Chinese authorities that lead to confusion, which was one of the rebuttals to Carnes' accusations against Silvercorp.

Still, it was Citron Research that revealed fraudulent operations at China Biotics and China MediaExpress, where the SEC charged not only its CEO with fraud, but the Chinese affiliates of accounting powerhouses Deloitte, KPMG, PricewaterhouseCoopers, BDO, and Ernst & Young with impeding its investigation. It was Muddy Waters that uncovered the fraud at Rino International and hounded Focus Media out of the public markets. Even Alfred Little had a hand in getting Sino Clean Energy and Deer Consumer Products delisted.

Yet if the securities regulator's accusations are true, it appears Carnes overplayed his hand. He maintains his innocence, though, and says his allegations against Silvercorp have panned out. The British Columbian authorities, for example, didn't visit Silvercorp's properties in China as Carnes' investigators did, and the miner ultimately revised downward its resource estimates.

Even in the face of its declining share price, which no doubt has been beaten down in part because of the collapse in precious metal pricing, Silvercorp was able to bolster investor confidence by meeting the allegations forthrightly, going so far as to sue Carnes and others for defamation. While that went nowhere, and others like Deer have tried similar tactics by putting up a bold front, there's a willingness to give a company the benefit of the doubt if it fights back against the accusations.

Once all is said and done, a company's best refutation is to prove short sellers wrong. The truth will out, and if the charges are false, then, as the saying goes, living well is the best revenge. I appreciate the work short sellers do in ferreting out corruption and fraud, but if they're found engaging in the same activities, then they should be similarly punished. If that's the case with Silvercorp, then it will have found a silver lining to its own troubles.

Author

Rich has been a Fool since 1998 and writing for the site since 2004. After 20 years of patrolling the mean streets of suburbia, he hung up his badge and gun to take up a pen full time.

Having made the streets safe for Truth, Justice and Krispy Kreme donuts, he now patrols the markets looking for companies he can lock up as long-term holdings in a portfolio. So follow me on Facebook and Twitter for the most important industry news in retail and consumer products and other great stories.